Is this the time to invest in auto funds?

Though the stage appears to be right for auto stocks, there are a few risks you cannot ignore.

Auto sales numbers, published on June 1, 2023, infused some life into auto stocks. By June 5, the Nifty auto index was up 2.61 percent and the Nifty 50 TRI was up 0.4 percent, compared to the closing price of May 31.

While traders may want to take their bets on individual picks, mutual fund (MF) investors may want to take exposure through funds focusing on automobile manufacturers and transportation and logistics-related companies.

What is on offer?

There are actively managed schemes (transportation and logistics funds) by MF houses, such as UTI, ICICI Prudential and Bandhan, which invest in stocks of companies that have businesses in the transportation and logistics sectors, including automakers.

These are thematic funds and are benchmarked against the Nifty transportation and logistics index. Also, there are passively managed schemes tracking the Nifty Auto Index offered by ICICI Prudential and Nippon India Life AMC.

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While the former has fund manager risk, it comes with a hope for returns in excess of benchmark. The latter aims to offer returns offered by the underlying index – the Nifty Auto Index -- before costs and tracking error.

Why look at this sector?

Auto, transportation, and logistics are important sectors of the Indian economy. They are considered as barometer sectors as heightened economic activity gets reflected in the volumes of these sectors.

These sectors suffered when lockdowns were announced. However, the situation has changed a lot after that. The logistics activity has already surpassed the pre-COVID levels. Analysts are upbeat about the economic activity in this space, especially in the auto sector.

Harish Bihani, Senior Fund Manager, ICICI Prudential Mutual Fund, is of the opinion that the sector’s volume cycle is still in the early part of the recovery. He foresees steady improvement. “Also, margins will continue to have tailwinds due to cooling commodity prices. Hence, if earnings do well in the medium term, the sector could continue to do well,” he added.

Bandhan MF and ICICI Prudential MF launched their actively managed transportation and logistics schemes in October 2022.

Himanshu Singh, Research Analyst, Prabhudas Lilladher, says: “Though we have seen improvement in volumes and margins for most companies in the auto sector, a seasonal slowdown is possible in the rainy season. Though listed two wheeler-manufacturers have shown good growth and are expected to post good numbers in FY2024, there will be challenges in the form of high penetration of two-wheelers and ongoing disruption from electric vehicles in the medium term. Passenger vehicles are in a better position, given the structural tailwinds.”

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As private sector capital expenditure catches up as new production facilities are set up, thanks to various government policies, including production-linked incentives, demand for transportation and logistics should go up.

Do not ignore risks

Though the stage appears to be right for auto stocks, there are a few risks you cannot ignore. These sectors are linked to the growth in the broad-based economy. If the economy slows down, these sectors suffer. The current situation of relatively high interest rates is seen detrimental to the demand for vehicles. The interest rates may take some time to come down.

Commodity prices have come down, of late. This is expected to help these companies in terms of better margins. However, a bounceback in commodity prices will go against the fortunes of these companies.

The changing regulatory environment can affect auto companies’ margins. Focus on less-polluting vehicles through norms with requisite reduction of emissions by engines, reduction in subsidy for electric vehicles, export incentives and vehicle scrappage policy may keep impacting the earnings of companies.

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The valuations of many stocks are factoring in future growth. Rising investor participation has ensured that stock prices climb up. Over the last one year, the Nifty Auto TRI has gone up by 30 percent against the 13 percent growth registered by the Nifty 50 TRI.

Though many analysts are bullish on the auto sector, there are a few who prefer to advise investors to take a more measured view on the sector.

Vinayak Savanur, Founder and CIO, Sukhanidhi Investment Advisors, says, “The auto sector is cyclical in nature. Though we can see growth in the sector now, we should be prepared for interim volatility. The auto sector can best be tapped through consumer funds.”

What should you do?

The auto sector is duly represented in flexi-cap funds, with around 7 percent allocation, on an average, as on April 30, 2023, according to Value Research. So, even if you are not investing in a dedicated auto sector fund, you are not depriving yourself of the possible growth in this sector. You must get both the entry and exit right to make money in thematic funds. Auto as well as transportation and logistics funds are no different.

If you have a positive view on these and want to bet on a cyclical upturn in the Indian economy in the medium to long term, you should allocate some money to them. If you are keen on avoiding fund manager risk, you have the option of investing in schemes that track Nifty Auto Index.